Significance of Volatility Index (VIX)

Volatility index is a tool aimed to help investors understand market risks better and take decisions accordingly. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage terms) based on the order book of the underlying index options.

VIX, introduced in 1993, is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. Since inception till October 2008, the average value of VIX was 19.04. It reached an intraday high of 89.53% on October 24, 2008.

The chairman of the Securities and Exchange Board of India, Shri C.B. Bhave, launched the index called India VIX in April 2008. It captures the implied volatility embedded in options prices, and is based on the Nifty 50 Index Option prices. India VIX is a barometer of investor consensus on market volatility expressed through option pricing. Whereas the Nifty 50 signifies the directional moves of the market, India VIX indicates the expected near term volatility. How to measure the fear or uncertainty in the market? Generally, if the VIX is going up it means the fear in the market is going up leading to a market decline, and if we see the VIX falling it means the fear in the market is reducing leading to markets rising. Higher the implied volatility, the markets tend to correct to appropriate levels and vice-versa. India VIX after hitting a range of over 70% during October-November 2008, has since come down significantly. It closed at a level of 45.16% on December 26, 2008. However, a level of more than 40% still indicates a lot of fear amongst the market participants. The markets may not be out of the woods yet.